ANALYSIS: The central bank’s inaction today will bring more rate hikes down the road

What began as a promising move in September, with the central bank of Turkey finally reacting to the rise in inflation and the extreme TL weakness with an unexpected 200 basis points rate hike (weekly repo rate to 10.25% from 8.25%) turned sour at its October meeting.

The bank kept the policy rate (one week repo auction rate) constant at 10.25% despite the market’s sure bet for another 175-200 basis points rate hike.  

Hence with such a no action and the obvious signal that the bank will hardly defy President Erdogan’s low interest rate order, the USD/TL that had advanced to 7.82 levels betting on positive real rates immediately weakened to another record low of 7.97.

The central bank of Turkey is once again labeled as unpredictable and not independent by investors as a huge number of them were seemingly waiting at the doors to re-enter the Turkish money markets.  Now that chance is apparently blown away.

Yet, the bank’s note embraced a change that policy setters will continue with back door tightening measures in the days ahead. The Committee altered the monetary policy operational framework so that the fixed +150 basis points margin between Late Liquidity Window lending rate (LLW) and overnight lending rate is now +300 basis points.

Since mid-August the bank has been escalating its average funding rate from lows around 6.5% to lately 12.6% with the help of the 200 bps rate hike. The march in Turkey’s CPI inflation to 12% with the 25% value loss in TL against the USD since the start of the year amidst “economic overheating” had urged the central bank to act.

The widening of the margin means that the bank will be escalating the average funding rate to roughly 14.5% from its current rate of 12.6%, offering de facto positive real rates.  Yet, once again the bank is doing the rate hike in an hindered way melting another big chunk away from its wounded credibility.

The bank now claims the overheating via the government stimulated credit boom is easing hence comes the “no rate hike decision.  The reaction to its unexpected pause in terms of rapid TL weakness will surely elevate its average funding rate as the bank is positioned to do at today’s MPC. Such 150 bps indirect rate hike could work to keep the TL/USD at around 7.90-97 range in the short term.

As the potential change in US Presidency after the US elections on November 3rd carries more trouble in US-Turkey relations TL weakness seems set to continue given the CBT’s policy choices.  TL/USD is likely to march over the psychological benchmark 8.00 with the headline CPI inflation to get stickier at 12-14% range.

The bank will eventually need to deliver more rate hikes in the coming quarter; carrying the average funding rate towards 17% from the current 12.6% and the soon to be 14.5%.  Because what is at stake given the level of TL depreciation is both the financial and the economic stability.       


The Monetary Policy Committee rational for the policy decision is below:

  • While global economic activity has shown signs of partial recovery in the third quarter following the normalization steps taken by several countries, uncertainties on global economic recovery persist. Advanced and emerging economies continue to maintain expansionary monetary and fiscal stances. The pandemic disease is closely monitored for its evolving global impact on capital flows, financial conditions, international trade and commodity prices.
  • The recovery in economic activity continues. Following recent policy steps, the normalization trend observed in commercial and consumer loans has become more pronounced. The expected moderation in imports has started with the phasing out of pandemic-related supportive policies. The strong recovery in exports of goods, relatively low levels of commodity prices and the level of the real exchange rate will support the current account balance in the upcoming periods.
  • As a result of fast economic recovery with strong credit momentum, and financial market developments, inflation followed a higher-than-envisaged path. A significant tightening in financial conditions has been achieved, following the monetary policy and liquidity management steps taken to contain inflation expectations and risks to the inflation outlook. Accordingly, the Committee has decided to keep the policy rate unchanged, while enhancing flexibility in liquidity management and continuing with liquidity measures until inflation outlook displays a significant improvement.
  • The Committee assesses that restoring the disinflation process is a key factor for achieving lower sovereign risk, lower long-term interest rates, and stronger economic recovery. Keeping the disinflation process in track with the targeted path requires the continuation of a cautious monetary stance. In this respect, monetary stance will be determined by considering the indicators of the underlying inflation trend to ensure the continuation of the disinflation process. The Central Bank will continue to use all available instruments in pursuit of the price stability and financial stability objectives.